Treasury Market Volatility explodes on Black Box Retreat

The retreat by so-called black-box traders and hedge funds caused orders for Treasuries to drop as much as 80 percent

During my lifetime of trading I have traded in and through many crisis events, Hunt silver collapse, 87 stock market crash, 98 LTCM blowout, 911 market shutdown, and the current subprime money market debacle. The one thing they all have in common is the evaporation of liquidity. I always hear stupid remarks like this one:

“We were seeing things that were 25-standard deviation moves, several days in a row,” said David Viniar, Goldman’s chief financial officer

The same kinds of idiocy were spouted by the Nobel winners at Long Term Capital Management. The flaw in these statements is the unstated assumption that the "model" is complete. The model is not complete because these models invariably make the implicit assumption that market liquidity is a constant. Nothing could be further from the truth. The one characteristic of big market panics is the shift from analysis of fundamentals like interest rates or earnings to a focus on preservation of capital and deleveraging. We all become Will Rogers who is reputed to have said "I am not so concerned about the return on my capital but the return of my capital." From return on to return of is a very significant change when the entire market place makes the switch.If we take the distribution of prices only from periods of collapsed liquidity Mr. Viniar's 25 standard deviations become more like 1.7.Every quant should tatoo on the back of his/her hand " the market is right not the model".